Hedging UK stock portfolios with gold and oil: The impact of Brexit

Abstract

The purpose of this paper is to examine dynamic co-movements and portfolio management strategies between UK stock indices (aggregate market index and sector indices) and each of gold and crude oil futures markets, during the Brexit referendum (2016) and the Brexit day (2021). Using multivariate GARCH models, the time-varying conditional correlations between the focal markets are extracted. Then, portfolio weights, hedge ratios, hedging effectiveness, and downside risk reductions are determined. The results reveal that, during the Brexit referendum period, gold and crude oil provide a diversification opportunity for the UK stock portfolios. Specifically, investors should give more weight to gold than stocks in their gold-stock portfolios, whereas they should allocate more funds into stocks than oil to minimize risk in their oil-stock portfolios. Based on hedging analysis results, crude oil appears more effective than gold in reducing stock portfolio exposure to downside risk and in improving the hedging effectiveness. Further analysis involving an event study considers the potential shift in the correlations between the UK stock market index (sector indices) and each of gold and crude oil during short-term event widows (one day, one day; five days, five days; and ten days, ten days) around the announcement day of the initial, transmission and actual Brexit periods or during each of these sub-periods. The results show that early news about Brexit led to a substantial change in the means of correlation coefficients in comparison to the tranquil period, where the initial UK stock price movements were driven by fears of a cyclical downturn following the referendum. 2021 Elsevier Ltd